Research Newsletter Online 4/2010

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Editorial: Bank capital and business cycle fluctuations

It is now fairly obvious that the most recent financial crisis poses major challenges to business cycle modeling, particularly to the tradition that uses dynamic stochastic general equilibrium (DSGE) models for quantitative business cycle analysis. These DSGE models have done quite well in accounting for the dynamics of the main macroeconomic variables at ’normal’ business cycle frequencies. Naturally, the meaning of normal business cycle fluctuations is open to debate, but one particular feature seems to be shared by all such fluctuations: fairly regular ups and downs in the growth rate of activity (GDP) as long as there are no major adverse or disruptive effects to or from the financial sector of the economy. ’Money’ seems to stay in the background, tracking growth paths that we tend to see as representing normal business cycle fluctuations.Read more

Great depressions: How important are financial frictions?

The wave of financial globalization that commenced in earnest in the mid-1980s was spurred by liberalization of capital controls in many developed and developing countries. Underlying the measures to deregulate international capital flows was the generally shared anticipation of possibly large benefits that could ensue from cross-border financial flows, benefits in the form of more efficient global allocation of capital and improved risk sharing possibilities.

The process of deregulation generated a surge of cross-border financial flows among most of these countries, but was unfortunately accompanied by a series of currency and financial crises in the 1980s and 1990s. While many share the perception that those developing countries that opened their capital accounts were more vulnerable to such crises than developed economies, the experience of the Nordic countries, particularly Finland, in the late 1980s and early 1990s, as well as the more widely shared experience of the most recent financial crisis and global recession clearly indicate that the large adverse effects of these crises need not be confined to developing countries.Read more

Economic crisis and exchange rate fluctuations

The economic crisis has had an impact on the exchange rates of many of the developing countries. For example, many of the raw materials-producing countries saw their currencies weaken substantially around the start of 2009, as commodity prices declined. But in the second half of the year, the same currencies appreciated. China’s currency, on the other hand, has been subjected to substantial upward pressure because China – as the only truly significant emerging economy – has continued to grow during the crisis. BOFIT researchers are currently pursuing a number of studies on exchange rates and related policies in the developing economies.Read more